New research from the Federal Reserve Bank of Dallas is supporting the need for a change in the interest rate that the central bank sets itself to achieve its monetary policy objectives. In a paper released Tuesday, Sam Schulhofer-Wohl, who serves as a senior advisor to Dallas Fed President Lorie Logan, says the tripartite general collateral rate, or TGCR, works better as a monetary policy transmission tool than the federal funds rate. The paper’s findings follow a recent speech by Logan, in which he argued that the Fed should move to targeting the TGCR rather than the federal funds rate, as it is a more reliable indicator of real short-term borrowing costs.
Schulhofer-Wohl said in the paper that the ability of federal funds rate changes to influence broader borrowing costs “has deteriorated in recent months,” while not disappearing completely. He added that “the transmission of the TGCR has deteriorated less than the transmission of the [tasso effettivo dei fondi federali, o EFFR] in episodes that occurred between 2018 and 2020 and has weakened only modestly in recent months, much less than the EFFR.”
For decades, the Fed has tried to achieve congressionally mandated goals of keeping inflation low and stable and job growth as strong as possible through changes in the federal funds rate, which is the rate banks charge each other to lend reserves to each other. However, changes in monetary policy, particularly through the use of large-scale bond purchases as a supplement to monetary policy, have flooded the financial system and made the federal funds market a marginal and low-volume sector compared to other money market sectors.
Despite the residual status of the federal funds rate, the Fed has continued to target it because some leading central bankers have noted that it continues to move in sync with other money market rates and, as a result, continues to have a significant influence on other money market rates.
NEW REGIME?
In his September speech, Logan warned that the status quo was unlikely to last. “Although targeting federal funds rates currently provides effective control of overall monetary conditions, the linkages are fragile and could suddenly break. The FOMC should eliminate this risk.”
Of the rates the Fed could target in place of the funds rate, the TGCR is the “best” option due to the active state of that market and the fact that the Fed’s “existing tools already provide effective control” of the rate, Logan said.
Any changes to the interest rate targeted by the Fed are technical in nature and deviate from the Federal Open Market Committee’s broader discussions on setting rates related to short-term borrowing costs. That said, it is important that the Fed is able to reliably influence borrowing costs, and this is fueling debate about appropriate targets.
The Fed is unlikely to change its target rate soon, and some observers believe the issue is secondary and unlikely to be addressed by Fed Chair Jerome Powell, whose term expires next May. (Reporting by Michael S. Derby, editing by Nick Zieminski)
